Does it make sense to switch to teaser Home Loan?

I purchased a Residential property in Ranchi in June 2009 worth Rs. 20 lakhs taking a Home loan of Rs. 15.6 Lakh from LIC Housing Finance @ 8.75% p.a. for 12 years. A few days back I received a letter from LIC saying the rates have been increased to 10% effective November 2009. Due to this my tenure has increased by 18 months.

So with so much promotional teaser Home Loans going in the market, does it make sense for me to switch. I did some calculation for the same which I would be presenting in the post for your valuable comments and feedback.

Present Loan Details
Loan Taken Rs. 15,60,000
Tenure 144
Interest Rate 9%
EMI 17,534

Since my EMI due date is 7th of each month I would be paying my January 2010 installment too before switching. So I did all my calculation based on what would I gain if I switch by February 2010.

January 2010 Situation
Principal Repaid Rs. 32,797
Outstanding Principal Rs. 15,27,203
New Interest Rate 10%
No. of EMI Left 156
Prepayment Penalty 2%

Teasers Loans under Consideration:

I did analysis for 2 switching options:

  1. Bank of Rajasthan Home Loan
  2. LIC Fix-O-Float Home Loan
Option 1:
Bank of Rajasthan Home Loan Scheme Details
Year 1 7.50%
Year 2 8.50%
Year 3 9.00%
Processing Fee 1%

This I found is the best teaser rate going in the market. The Loans Repayment are so designed that in initial years most of your EMI goes into serving the interest component and so very little principal repayment happen.

Like in my case I have paid Rs. 11,5301 in all & the Loan outstanding has reduced by only Rs. 32,797. So essentially 72% of my repayments till now have gone in serving interest. So having low interest in initial years helps.

Option 2:

LIC Fix-O-Float Home Loan Scheme Details
Year 1 8.90%
Year 2 8.90%
Year 3 8.90%
Processing Fee Rs. 7,500

Though this is not the best option still I am considering this as I can switch to this anytime I want without any hassles.

Cost of Switching

  • Prepayment charge = 2% of 1527203 = Rs. 30544
  • Processing charge for Bank of Rajasthan = Rs. 15272
  • Processing charge for LIC Fix-O-Float = Rs. 7500

Total Cost of Switching

  • Bank of Rajasthan – Rs. 45,816
  • LIC Fix-O-Float – Rs. 38,044

Assumptions:

Since the Home Loan is a fast changing product we need to make certain assumptions for the future interest rates.

  1. Here I assume that the interest rate would be 10% after 3 years for all the Loans
  2. If I switch my loan then I would invest the EMI difference in some Long term Instrument like Mutual Fund, Stocks which would give me a return of 10% per annum
  3. I need to calculate present value of all the future gains – So for this I take the discount rate equal to long term inflation rate of 6%

Calculating Switching Gains:

Now the question is how much would I gain if I switch to either option? There are two ways of calculating this.

  • In First case I can keep the number of EMIs same for all loans and then the difference in EMI would be my gain.
  • In second case I can pay same amount of EMI for all loans & see how much less number of EMIs I need to pay.

For simplicity I have shown only the first case. The results of both are almost similar.

Here I keep the loan tenure uniform for all the loans & see the difference in EMI for entire tenure. Then I would calculate the present value of EMI difference throughout the tenure. So here goes my first calculation table:

EMI Tenure EMI Amount Difference in EMI Value of EMI Difference Invested @ 10%p.a. till end of loan
LIC Fix-O-Float Bank of Rajasthan LIC BOR LIC BOR Present Loan
1 17,534 16,554 15,354 980 2,180 7,890 3,529
2 17,534 16,554 15,354 980 2,180 7,825 3,483
3 17,534 16,554 15,354 980 2,180 7,760 3,437
4 17,534 16,554 15,354 980 2,180 7,696 3,391
5 17,534 16,554 15,354 980 2,180 7,633 3,347
6 17,534 16,554 15,354 980 2,180 7,570 3,303
7 17,534 16,554 15,354 980 2,180 7,507 3,259
8 17,534 16,554 15,354 980 2,180 7,445 3,216
9 17,534 16,554 15,354 980 2,180 7,384 3,173
10 17,534 16,554 15,354 980 2,180 7,322 3,132
11 17,534 16,554 15,354 980 2,180 7,262 3,090
12 17,534 16,554 15,354 980 2,180 7,202 3,049
13 17,534 16,554 16,152 980 1,382 4,528 3,009
35 17,534 16,554 16,152 980 1,382 3,772 2,247
36 17,534 16,554 16,152 980 1,382 3,741 2,217
37 17,534 17,344 17,215 190 319 856 424
……
155 17,534 17,344 17,215 190 319 322 88
156 16,253 17,344 17,311 -1,091 -1,058 -1,058 -501
Total Gains at end of 156 months (A)  126,682  253,406
Switching Cost I need to pay right now (B)  38,044  45,816
 Had I not switched I would have invested switching amount @ 10% p.a.So switching amount value at end of 156 months (C)  138,845  167,209
 Net Gains at end of 156 months (A – C)  -12,163  86,197
 Present value of Net Gains discounting @ 6% p.a.  -5,586  39,590

I have not shown the calculation for all 156 months to avoid clutter.

So we can see I would gain around Rs. 40 thousand if I switch to Bank of Rajasthan but loose around Rs. 5.5 Thousand if I switch to LIC Fix-O-Float.

Some caveats:

  • I have considered interest rate to be constant @ 10% p.a. for my present loan which might not be the case. Going forward I think this is going to increase.
  • The assumption that after 3 years all the 3 loans under consideration would have same interest rate seems difficult.

Final Verdict:

So what’s the conclusion? Would I switch my loan? I think I would like to switch to Bank of Rajasthan Home Loan if I get the offer. Beside the Rs. 40 thousand saved, it has other benefits too. One being that it seems like step-up loan where you pay more amount as EMI as the tenure increases. And I being a salaried person I can assume my income would increase going forward. So my burden of EMI reduces. The second being no fluctuating EMIs for next 3 years.

But it would involve doing the home loan process from scratch. Moreover I live in Delhi & the loan is in Ranchi. This would mean additional cost in the form of paperwork, traveling, taking off from office & doing the running around. I am going to Ranchi tomorrow on holiday, so I would see if the switching is easy. If it involves more than one return trip probably I would not be switching.

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